Q: What is all this talk about “the loss of a step up in basis”; and, why is it so important?
A: The loss of a step up in basis relates to the state and federal (long-term) capital gains tax; and, it can potentially have quite a lot to do with estate planning. In Indiana, this tax is at 3.23%, but for most people, the federal capital gains tax is 15% (0% if you make less than $40,000 and 20% if you make more than $445,850). These rates are applied to real property you own that increases in value (“appreciates”) over time. For example, if you bought investment property 20 years ago for $100,000 and you sell it now at a current market value of $175,000, then you have realized a gain of $75,000. The government wants to tax you on your profit. One way people have planned to largely avoid this tax is to keep the property until death and have the beneficiaries sell it instead. This is because of a rule called a “step up in basis,” which allows a beneficiary to have its taxable basis for purpose of calculating profits be the market value of the property when it was inherited, not when it was originally acquired by the decedent. In our example above, if the landowner instead kept the $100,000 investment real estate and bequeathed it to his heir, and the heir sold it sometime later for $200,000, then the taxable gain on the sale is only $25,000 ($200,000 minus a new $175,000 basis). The basis “stepped up” from the original $100,000 basis that applied when originally bought to $175,000 when inherited. This is definitely worth considering since then-candidate Joe Biden called for a repeal of the step-up-in-basis rule in his tax plan while on the campaign trail as a way to increase the federal government’s taxable revenues. If repealed, our hypothetical landowner would likely stand to lose almost $12,000 in additional taxes on the sale of the investment real estate. Please consult your elder law attorney if you have concerns about the tax implications of your estate.